Has the RBA abandoned the 'narrow path'?

For more than two years, the Reserve Bank of Australia has pursued what it called a "narrow path" back to price stability: bringing inflation down without significantly damaging the labour market.

But following this week's rate rise and a fresh set of economic forecasts, Rabobank senior macro strategist Ben Picton believes the central bank may be moving away from that approach. 

The shift could have major implications for Australian workers, borrowers, and businesses.

The RBA lifted the cash rate by 25 basis points to 4.85%, its fifth increase this year and the highest level since 2008. 

Read more: RBA delivers fifth rate hike of 2026, pushing cash rate to 4.85%

The central bank now expects inflation to remain above 3% until late 2027, while unemployment is forecast to rise above 5% over coming years.

Speaking on the Savings Tip Jar podcast, Mr Picton said the more significant development wasn't necessarily the hike itself, but what the RBA's forecasts reveal about its inflation strategy.

"What they're saying is that they're expecting to build some spare capacity into the labour market."

"They think that that situation is going to reverse and the labour market is going to be slightly loose and that will be placing downward pressure on inflation," he said.

A shift in the inflation battle?

The concept of the "narrow path" has underpinned the RBA's messaging throughout much of the inflation cycle, reflecting hopes inflation could fall without a large rise in unemployment.

But Mr Picton believes recent forecasts point to a change in emphasis.

"To a certain extent we've abandoned the narrow path. That's out the window, and now we're looking to actually create some spare capacity in the economy, create some slack in the economy."

His comments come as the RBA itself acknowledges the labour market remains tighter than previously thought.

Last week, RBA Governor Michele Bullock told a Senate committee that the bank now believes the labour market is "a little tighter than we had previously judged", despite the recent rise in unemployment.

The governor also warned that inflation is likely to run hotter than the central bank expected only a few months ago.

"Inflation will therefore likely be higher than was our base case in August," Governor Bullock said.

Did Australia leave rates too low for too long?

Mr Picton argues Australia's inflation challenge stems partly from policymakers trying to minimise economic pain while bringing prices under control.

He contrasted Australia's approach with countries such as Canada and New Zealand, which moved earlier and more aggressively to curb inflation.

"Most other developed economies took a different approach. They raised interest rates earlier, they raised them higher, and they clamped down more on aggregate demand in the economy."

As a result, Mr Picton believes Australia has less spare capacity in the economy than some of its peers.

"We didn't really do the hard yards."

He also pointed to government spending as one factor contributing to ongoing inflation pressures.

"Here in Australia we've had still quite robust growth in government spending."

The RBA's latest forecasts suggest domestic capacity pressures remain stronger than previously assumed, even as economic growth slows.

Near the end of the rate cycle?

While Picton sees signs the labour market may need to soften further, he also believes the RBA's latest communications were less hawkish than the headline rate rise suggests.

Markets focused on the split vote, the removal of language signalling a readiness to keep hiking, and comments from Bullock that some board members favoured taking time to assess the impact of recent rate increases.

"There is a little bit of dissent there amongst the board members... It sounds like they might be in wait-and-see mode."

That doesn't necessarily mean rates have peaked. Mr Picton warned that escalating conflict in the Middle East and higher energy prices could yet force the RBA's hand.

"If we see broad-based escalation across the Middle East and we see energy prices legging higher again, then that could be the thing that disrupts the best laid plans of the RBA and maybe it changes the game."

The RBA has already cited higher global energy prices as a key reason inflation is now expected to stay elevated for longer.